Jitters grow over Greece debt swap

Warning of painful consequences if Greece succumbs to hard default

By

WilliamL. Watts

FRANKFURT (MarketWatch) — Greece continues to rattle investor nerves ahead of a Thursday deadline for private investors to voluntarily offer up Greek government bonds in a debt swap that will cut the value of their holdings by more than half.

Strategists blamed jitters over the process combined with concerns over global growth prospects as spoiling investor appetite for risk on Tuesday, sending European and U.S. equities lower and undercutting the euro and other risk-oriented currencies.See Market Snapshot.

“It will only become clear toward the end of the week how many investors have agreed to the ‘voluntary’ restructuring of Greek debt,” said Lutz Karpowitz, currency strategist at Commerzbank.

The Institute for International Finance, which helped negotiate the terms of the bond swap, reportedly warned in a recent memo that a so-called hard default by Greece could cause at least 1 trillion euros ($1.32 trillion) in damage to the euro-zone economy. That figure includes the need for aid for Italy and Spain to keep the crisis at bay as well as €160 billion in bank recapitalization costs, Reuters reported Tuesday. See full document as shown in the Athens News.

A failed debt swap would likely scuttle Greece’s second bailout from the European Union and the International Monetary Fund while reigniting fears of a potentially chaotic default as early as March 20, when the country faces a €14.5 billion bond redemption.

On Monday, 12 members of the steering committee of private investors that helped negotiate the Greek deal — including Germany’s Deutsche Bank (DBK) and Commerzbank (CBK) as well as French bank BNP Paribas (BNP) — said they would participate. They account for around 20% of total private holdings of Greek debt, according to Michael Hewson, senior market analyst at CMC Markets in London.

“We can probably expect a further drip feeding of these types of announcements between now and Thursday’s deadline,” he said.

In a statement Tuesday, Greece’s Public Debt Management Agency said it told bondholders at a meeting in Frankfurt that should the debt swap fail, it would mean Greece being denied aid from the official sector, leading to more onerous terms for debtholders.

The agency also warned that the country’s bailout plan “does not contemplate the availability of funds to private-sector creditors that decline to participate” in the debt swap.

Terms of the deal

Under the swap, investors would exchange existing Greek bonds for new debt worth 46.5% of the face value of the old paper. This consists of bonds with maturities of up to two years worth the equivalent of 15% of the face value of the old bonds.

The remaining 31.5% will come via new, long-dated Greek bonds. Investors also receive securities that allow them to reap higher interest payments if the economy outperforms a baseline set by the EU and the IMF.

Unless at least 75% of bond holdings are tendered for the swap, the deal would likely be canceled, according to the terms of the tender offer circulated by the Greek government.

Most strategists say Greece should meet that threshold, but they see participation falling short of the near-100% participation needed to convince the EU and the IMF that Greece can meet its long-term debt-reduction goals.

The bond swap is part and parcel of a broader rescue agreement with Greece’s creditors that will see the country receive a €130 billion rescue from the EU and the IMF, which must be convinced that the nation can make headway in bringing its public debt down — from about 160% of gross domestic product currently to around 120% by 2020.

And those numbers don’t work unless Greece sees heavy participation in the bond swap, on the order of about 97%, said Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y.

As long as the bonds offered total more than 66%, Greece can move to trigger collective-action clauses inserted retroactively into the bonds, forcing all private bondholders to participate. Finance Minister Evangelos Venizelos on Monday indicated Greece wouldn’t hesitate to do so if deemed necessary.

“It seems unlikely that sufficient numbers of investors will agree in a first step. However, even the activation of a possible collective-action clause requires a certain level of agreement. The latter is set at very low levels, but there is a small risk that the restructuring fails and Greece thus defaults,” Karpowitz said.

If the clauses are activated, it would likely be enough to convince the International Securities and Derivatives Association to declare a “credit event,” forcing the payout of credit default swaps, analysts said. Swaps are derivative instruments used by market participants to protect against, or speculate on, default.

While total net exposure of $3.2 billion isn’t seen as carrying a big risk to the banking sector, the prospect of a credit default swap exercise still sparks some nervousness, economists said.

If they’re triggered, “no one knows what will happen next,” Weinberg said.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.